Vietnam in a world larger than US and China

Date: Thursday, December 20, 2018Source: Vietnam Investment Review

As the US-China trade war rages on and protectionist sentiments spread out around the world, manufacturers are planning to relocate their product to Vietnam and avoid rising tariffs. Frederick Burke, managing partner at Baker McKenzie Vietnam, shared his view on this issue.

In recent months, we have had manufacturers from China visiting and saying they want quickly move production to Vietnam to avoid 25 percent duties that US president Donald Trump is imposing on various Chinese products.

The Case of Vietnam

What makes Vietnam attractive to overseas manufacturers? First, Vietnam started off as a low value-added production base, but the country is now moving up the supply chain very fast. In fact, it is no longer economical to make T-shirts here, and we have seen garment manufacturers from South Korea and Taiwan struggling because of rising costs after year.

To make rising labor costs worthwhile, Vietnam understands that it needs to manufacture products with a higher margin. Samsung is one successful case. Originally only 2 percent of the added value was created by workers in Vietnam – but now, step by step, the suppliers are coming too. We have helped some suppliers set up store here, establishing joint ventures with local companies and rising the involvement of small-to medium sized firms.

Second, Vietnam is preparing for Industrial Revolution 4.0 to enhance its competitiveness. The government has quickly perceived the trend and taken action. At the World Economic Forum on ASEAN 2018 in Hanoi a few weeks ago, Vietnamese and other regional leaders talked about the importance of educating workers for IR 4.0, which includes for example coding, operating, and maintaining a robot rather than doing the job by hand. There are concerns that due to this trade war, Us companies may relocate their production bases to their homeland. This to me seems far-fetched for most, because the production costs in the US are far higher than in Vietnam.

The few firms that are indeed moving back actually want to replace most jobs with automation, robotics, and artificial intelligence. The jobs for American workers would be in engineering, design, branding and management of hi-tech production processes. It will be hard for Vietnam to compete with robots, thus learning about IR 4.0 is very important.

We think companies shifting production to Vietnam is a net gain for the country in the short run. However, in reality, a lot of investors are also taking the “wait and see” attitude, because shifting production takes time and they are not sure how long the trade war will last or what the outcome will look like. The trade war really adds an element of unpredictability to the global trade system. In other words, investors do not want to move their production to Vietnam too quickly and then find that the trade war is over next month!

Another issue is that Vietnam has a large trade surplus with the US, standing at $34 billion last year. If this trade imbalance gets worse quickly, the negative attention may be shifted from China to Vietnam. Fortunately, right now there are strategic geopolitical reasons why this may not happening, as both the US and Vietnam have similar interest in keeping the region stable and growing as it is. Lastly, the country of origin requirement will be a big headache. There are different methods to calculate how a product is classified, and we have seen made-in-Vietnam kitchen steel cabinets that use Chinese steel as one of their components and were classified as Chinese origin and therefore subject to the higher tariff in the US. In fact, the revised North America Free Trade Agreement has 234 pages on country of origin requirements, which are highly technical and very complex. It may be particularly challenging for manufacturers whose different stages of the supply chain involve countries with different trade deals. This is why anyone thinking of moving their production to Vietnam should think carefully about whether they can meet the country of origin requirement, and think of solutions.

Prospects of different trade deals

Some people are talking about the possibility of a bilateral trade deal between the US and Vietnam, one that replaces the US’ membership in the Trans-Pacific Partner (TPP, now called the Cooperative and Progressive Agreement for Trans Pacific Partnership (CPTPP). I personally think bilateral deals are not easy, as the US and Vietnam tried it back in 2008 but did not succeed.

Right now, the US is very busy with other countries, so it may take longer to attend to Vietnam. Specifically, the US has just concluded negotiations with Canada and may soon turn to Japan, which is going to be very difficult because Japan had agreed to 20 years of US requests for the TPP, and the country is unwilling to do it again on a bilateral basis. There are also practical issues with bilateral trade deals. They do not have the same impact as multilateral agreements, as they offer much fewer choices in the supply chain. For instance, if you produce a car with more than 1,000 components from a dozen different countries, you would prefer a trade deal that includes all of these countries. At the same time, the regulatory coherence and good laws of a multilateral partnership will help Vietnam develop and reform faster.

That said, there have been success stories of bilateral trade deals. The South Korea-Vietnam FTA, for example, has driven agricultural investments from elsewhere in the ASEAN to Vietnam, as Vietnam enjoys declining import tariffs on its sales of agricultural product to South Korea.

In the face of rising protectionism, some markets are actually thinking about joining the CPTPP. Taiwan and the UK are two examples, especially the UK following its exit from the European Union, schedule for March, 2019. If the UK indeed joins CPTPP, exports from Vietnam to the UK would be at an advantage compared to Eastern Europe from which the UK traditionally sources its light industrial products. Also, there will be a lot of opportunities for British companies – those in aviation, automotive, whiskey, and spirits – to sell more to Vietnam.

I think consumers around the world will soon realize that closing borders will not help the economy in the long term.

Advice for manufacturers

My first advice for companies looking to move their productionsto Vietnam would be checking if they can meet the country of origin requirements under different treaties. It is important to see if their product is treated as made in Vietnam and not as a product with Chinese components and thus still subjected to tariffs.

The second step is to understand that Vietnam operates differently from China. The country is moving and changing very fast. We are talking about movements towards IR4.0 and manufacturers should look at that too. These days, you cannot just come to Vietnam simply for cheap labor.